Chart of Accounts

The chart of accounts is the backbone of your accounting system. This episode discusses how to create a Chart of Accounts that benefits the company and satisfies your tax preparer.

Transcript

Setting up the Chart of Accounts

Welcome to another episode of the “Not Boring” Boring Small Business Bookkeeping and Accounting Podcast! My name is Paul Rosenblum—Bookkeeper, QB trainer, and accounting and bookkeeping trainer in Webinars. 

After you form an entity for your company, and decide what software to use, and start spending money and tracking Startup Expenses as we have discussed in previous episodes, eventually you will need to set up a Chart of Accounts in your accounting system for your company. 

I have done many webinars showing how to set up a chart of accounts -- and you can find some of those videos on www.bookkeepermensch.com.  I also do webinars on this subject for BOC – AKA The Business Outreach Center which is a non -profit organization in Brooklyn, NY.  If anyone wants an invite to upcoming free webinars that they sponsor, please let me know by emailing me at Bookkeepermensch@gmail.com and I will put you on their mailing list. 

Now, let’s continue our trek into Small Business Accounting.  This week, we will discuss all about the Chart of Accounts.  Since I primarily do bookkeeping for smaller to mid-size companies, I set up the expense accounts relatively close to the tax form that the company will be using.  For an example, if they are a Sole Proprietorship or a single member LLC, I will set up the expenses as they are on the Schedule C form to make it easier for the accountant or the tax preparer at tax time.   I might use slightly different terminology, but the meaning is the same.  Then, I add specific categories that might be unique for that company and any subcategories that they might need. For an example, rent is a standard expense account, but as ‘sub-categories’ for rent, a company might pay rent on a storage unit, or on rental equipment.  These would be attached to the main category of rent, but in most accounting software, be indented under the main category of rent so all the sub-categories will add up to the main rent category. 

Another example would be Auto or Vehicle expenses. The sub-categories should be gas (or fuel), Vehicle Maintenance and Local Parking. (Most accountants have asked me for those categories for many years. 

If you are traveling for business and you rent a car and pay for parking for that car, then that parking expense should be under a TRAVEL expense.  The typical travel expenses are: 

Lodging (or Hotels)

Parking

Car Rental

Airfare

Meals (travel)

Trains or busses (longer distance, not local travel)

If you are traveling, and you must purchase some Aspirin at a drug store, that purchase would not be a travel expense, it could go under another standard expense account which is in every chart of accounts called:  Office Supplies, or Office Expenses.  You don’t have to separate office supplies that you buy locally and what you buy on the road. If you are purchasing a gift for a client when you are traveling, that purchase would go into an Advertising Expense account, sub-account “Client Gifts” if it’s purchased locally or on the road in Las Vegas at a work convention. 

Meals is an interesting category.  Before 2017, the IRS category used to be called “Meals and Entertainment”, but the law changed, and entertainment expenses are no longer included.  So, If you bring a client to a Broadway show or a movie, it’s no longer deductible for the business. That would be a personal expense under the Equity section of the Chart of Accounts, or a Distribution account (also Equity) If the company is a partnership or a corporation.

When I set up the Chart of accounts, I use the term ‘Business Meals’.  The sub-accounts are as follows: 

Client Meals (Restaurants and Delivery) (50% deductible)

Staff Meals (if you purchase lunch for ALL of your employees, this is 100% deductible)

Working Meals (If you are a one-person operation) – Meals that you as the owner of the company get delivered and you eat and work at the same time and do not stop work to eat.  (100% deductible)

And in some cases:

Business Development ---   This would be under meals because if you take out a perspective client for a meal, you really are developing potential business, but it’s still a meal. 

As I said earlier, Meals (Travel) is under the Travel category because if its ever looked at by the IRS, and they see Lodging, Airfare, trains, etc, they also want to see meals as a travel expense.  If you eat at the hotel that you are staying at and don’t eat at any outside restaurants, then you need to get an itemized receipt showing the room costs vs the meal costs from the hotel.  Also, in the travel category, all business trips should be on a calendar of some kind, so if audited, you can prove your traveling schedule matches the travel expenses in the books.  

What do you do if you are traveling for business, and you are at the airport and buy lunch when waiting for your flight to take off? If you buy water at the airport, that is considered an Office Expense. Or a little snack that is in a bag that you can eat like chips or nuts, could be an Office supply.  But if you purchase a whole lunch at an airport restaurant, what category do you use?  Is it a Business Meal or a Travel Meal?  Each one should be looked at by the accountant because they all have different opinions, but in general, if you are at your local airport leaving for a business trip, I’d put that in a regular business meal.  If you are at an airport returning from your trip, I’d put that in a Travel meal.  No definite rules here, other than the accountant or the tax preparer looking at the overall numbers in both of these categories and making a decision on what makes sense in terms of the overall numbers. Even during an audit at the IRS, they will not pick on the categories since travel meals and local meals are both 50% deductible. 

Many years ago, I had a client audited (by mail, not an in -person audit) because the client was moving from NYC to California and took several trips to California when they were finding an apartment and having meetings with the new company that the client would be working for as an employee.  At that point, the client was self-employed. The IRS was questioning the amount in the total travel category on the tax return, so we had to send specific bookkeeping reports as to what was in the travel category and the client had to explain each and every cost.  At the end of the day, we had to move some of those expenses to a Personal Expense for ‘moving expenses’ which are tax deductible on the 1040 personal tax form.  They didn’t all belong to the business as tax deductions on a schedule C. So, the client didn’t lose any deductions, however, the IRS wanted to see those deductions differently since the client was closing her LLC and moving to start a W2 job for a large company. Hence, the accounted had to amend that tax return to satisfy the IRS. 

Local Transportation--- This category catches all.  I name it “Taxi and Local Transportation” which is  on most tax forms. You don’t need sub-accounts on this category (unless you want to) This category includes MTA subway and busses, bicycle rentals, gas for the scooter that takes you to work, taxis, Uber, Lyft, and other modes of transportation. Even if you travel out of state on business, once you are in another city or state, and you take a taxi or a subway trip, it’s still considered local travel and not a regular travel expense like a hotel or airfare.  If you rent a car for a few hours to be used 100% locally, it could go under Local Transportation and maybe a sub-account called ‘Rental Cars’. 

What do you do if you are using your own personal car for business purposes?  There are a few ways of accounting for this.  

1. You can use the Auto Expense account that I spoke about earlier and track the gas, maintenance, and parking for the year.  You can then determine the percentage of the time that you use the vehicle for business vs personal.  If it’s determined that you use the vehicle for business 20% of the time, then 80% of those expenses get adjusted out of the business expenses by the accountant or a good bookkeeper who knows how. 
2. You can take Odometer readings every time you use the vehicle for business purposes. You can track your miles for the year, and at the end of the year get reimbursed for use of your personal vehicle.  In 2022 it’s 58.5 cents per mile would be reimbursed to you personally Jan. – June, (no income taxes on that), and the last 6 months of 2022, it went up to 62.5 per mile.  So, depending on how many miles you have traveled for the year, the reimbursement could cover all of the repairs and maintenance to the vehicle.  
3. There are some fancier ways of dealing with a personal car usage for business as well. If you have a Corporation, the company can purchase your personal car and then it’s owned by the company, so it’s tax deductible for the company as an Asset.  However, if there is litigation against the company, the vehicle isn’t protected if it was owned by you as an individual.

If you have a personal vehicle, rather than tracking it as a regular business expense under Auto expenses, you could track it as a ‘Personal Vehicle” , under the category of “Other Expenses’ which is at the very end of your chart of accounts.  And then at the end of the year, the accountant or your bookkeeper can make an adjustment between business expenses and personal expenses. 

For small business that are in the process of growing, having a longer chart of accounts with sub-accounts could be a good thing for the business owner.  It allows the owner to see exactly how their money is being spent and it easier to make decisions on where to cut costs. However, with many people using the online versions of accounting software, usually there is a limit to the number of accounts you can have in the Chart of Accounts. In QuickBooks, for an example, you are limited to 250 accounts (which really isn’t much at the end of the day), except for the Advanced edition which is around $200.00 monthly.  The advanced edition has unlimited accounts in the Chart available to you. 

However, as the company grows, the number of accounts generally decreases.  Once you are making money and you have definite patterns in how money is made and spent, you don’t need nearly as many specific subaccounts.  You can have one Bank Charges, rather than sub-accounts that include, Wire transfers, monthly bank fees,and foreign transaction costs.  You also could have one Office Supplies expense, rather than Coffee, general supplies and water.

Larger companies (and sometimes smaller companies as well), have a different philosophy on how they want to see their Chart of Accounts. Rather than all the sub-accounts and all the specific categories, they might want to see Operating Costs vs ‘Soft Costs’. This is more difficult at tax time for the accountant to pull out the categories in the books to match the tax forms, but that’s ok, if it helps the business owner manage their own company. 

Operating Costs would be Rent, Payroll, regular monthly maintenance of equipment or plumbing, and the softer expenses would be meals, travel, Dues and Subscriptions, local travel, office supplies, and other things that could be adjusted as the company can afford these extra expenses.  The operating costs would be what we call a ‘nut’ --   that is --- costs that are fixed and NEEDED to keep the company going.   The absolute minimum -- rent, in some cases, property taxes, payroll, subcontractors, and repairs and maintenance depending on the kind of business you have. If you develop a chart of accounts that way, it’ll look much different from the Chart of Accounts that I was talking about for most of this episode. 

Please email me at Bookkeepermensch@gmail if you would like me to email you a sample of the chart of accounts that I have been talking about today in this episode.  Also email me if you have any specific subjects that you would like me (and a guest) to discuss in upcoming episodes. 

If you have any questions about this or earlier Podcasts, please email me so that I can answer those questions in upcoming episodes. 

A last thought here -- my default thinking of the software to use for most of my clients is still the Desktop version of QuickBooks (which is a very popular software here in the United States).  It’s a very robust software with unlimited chart of accounts so that I don’t have to worry about hitting a limit.  It’s now an annual subscription-based software starting in 2022, but much less expensive than the online versions.  And additional software that is available for the desktop edition which allows you to collaborate between two users at two different locations using the internet that you can get for around $15 a month. 

I have had clients who have started off in the desktop edition, decided to move to the online version, and found that the reporting wasn’t as good as what they had hoped, and realized that it was more money on an annual basis, and decided to go back to the desktop edition.  In my practice, still the majority of my clients are on the desktop edition and not the online version.  

Some of it depends on the personality and the needs of the business owner. There are business owners who want to check their books every day -- they want to see the deposits, and the expenses and run reports daily or at least 2 or 3 times a week.  They can do that more easily with the online editions. I do, however, have requests all the time from clients who are using the desktop edition which lives on my PC, for reports that they need -- and I will stop what I’m doing and send them what they need within minutes if I’m not teaching a webinar or in a meeting with another client in my office.  So, all of this depends on the personality and needs of the business owner and the personality of the remote bookkeeper, which is getting more and more the norm for small businesses these days. Because business owners can’t get into their own books whenever they want, a large part of my practice is customer service – that is – serving the clients’ needs even after 5pm and even on weekends, which I am more than willing to do unless I’m on vacation or not in front of a computer.

The Chart of Accounts if the whole backbone of your company -- so the categories are really going to tell you what you need to know about managing your company and gives you the information on making decisions moving forward with the company in the future. 

Thank you for listening – And I apologize for the gap between episodes, but it’s been a very period the last month or so.  I hope to be back on a regular schedule moving forward.  

As always---- I’m Paul Rosenblum.  Thanks for listening!